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The Long, Slow Death of Debt

If too much debt caused our financial crisis, getting rid of it is the solution.

The good news is, we are. It gets repeated over and over again in the media that we're not recovering from the recession -- and doomed for another crash -- because nothing has changed. But plenty has. Household debt payments as a percentage of income have plunged over the past four years, now down to the lowest level since the early 1990s and comfortably below the long-term average:

Source: Federal Reserve.

Some of this decline is from consumers paying debt off. Some is from big banks writing it off -- consumer-centric banks like Bank of America (NYSE: BAC) and Citigroup (NYSE: C) have been jettisoning bad debt like there's no tomorrow. Some is from real wage increases. Some is from inflation. The reason doesn't matter. Consumers have much, much less real debt now than they did a few years ago. The plunge has been quick, and it's ongoing. That's what's important, and it's what plants the seeds for recovery.

But hold on, you say. Sure, household debt has plunged, but it's been replaced by government debt. While consumer debt has been falling at a record pace, government debt has been rising at a record one. Out one end, in the other. The tag line du jour is that you can't solve a debt problem with more debt. You still end up in a cesspool. "All we have achieved so far," writes one commentator, "is to move liabilities from private to public balance sheets, effectively burdening tomorrow's taxpayer."

There's some truth to this, but only a little. Private debt has been turned into public debt, but not all of it, and not as fast as private debt is being shredded. Total economywide debt -- that includes household debt, corporate debt, pension debt, state and local government debt, federal government debt, or anything that rhymes with the word debt -- as a percentage of GDP shows the total debt load is indeed falling:

Source: Federal Reserve.

Two ways to look at this chart.

One, the trend is down. That's good. The economy as a whole is shedding debt. Embrace it.

Two, wow, the current level is still astronomically high. Whatever progress we've made, it's peanuts in the grand scheme of things. We've got years of work to do.

Last summer, Bill Bonner of Agora Financial made some smart comments about this topic:

Consumers are paying off debt so quickly. Faster than the government is creating new debt, in fact. Looking at the latest figures, it's about a $500 billion net payoff per quarter. That's $2 trillion of debt that's being paid off each year. So let's do the math. If we were at 300% total credit market debt to GDP, and a comfortable average is 150%, then we need to pay down, let's say, about $20 trillion. So that's 10 years at current rates.

I like that: 10 years. It's a nice round number. It's also what history shows: These things typically take about 10 years to pull out of. This correction started in 2007, so it will probably last until around 2017. So seven more years to go. And that's only if everything goes according to plan, of course. Things could change at any moment.

Things have changed a little since then. You can probably tell from the chart, the net payoff rate slowed over recent quarters. Last year, debt-to-GDP was falling between 1% and 2% every quarter. This year it's more like 0.6% to 1% per quarter, largely as the payroll tax cut swelled federal budget deficits.

One of a few things should happen from here. One, the trend stays the same, in which case it takes years, maybe decades, for total debt-to-GDP levels to revert to normal. Two, the trend picks up, and normalcy is hit sometime later this decade, as Bonner hints at. Three, consumers keep retrenching and the federal government hits a deal to really tackle public deficits over the coming decade, in which case a normal, sustainable level is hit over the coming years.

In any case, we've moving in the right direction. The root cause of our misery is being tackled. You can say a lot about our economy. Just don't say nothing has changed.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

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Seems to me that companies taking on debt at a low interest rate with anticipation of growth, expansion, etc is quite a good thing. If I'm a stable company with a solid balance sheet and can borrow from bond investors at a low rate to pay for an asset that produces income at a higher rate this is a very good time to do so.

Problem with consumer debt is that it is rarely for an asset that produces income. And no those NASCAR champions plates from the Franklin Mint do not count.

I wonder if we can see the same data without the mortgage to satisfy exeter17 that consumer debt is actually declining.

My econ. Professors MANY years ago were all Keynesian. I recall they were of the opinion that taking on debt was an advantage to the debtor because of inflation. That is, the debtor would be repaying their debt with dollars worth less than those they received from the loan(s).

I have you looked at this perspective? Do you think it is relevant? Just a thought.

I wonder what U.S. debt would be if they analyzed who owes what to whom and just balanced the books? If A owes B $10, who owes C $10, who owes D $10, who owes A $10 .... nobody owes anybody anything. So how much does this apply to the world today? Or are we up to our necks in debt and have nothing owed to us?

Lets see...our money supply expands by one method - debt. So now we stop the debt growth and expect the economy to grow simply because some have reduced CC debt. The price is record bankrupcy levels, unemployment and the under-spoken "quantitative easing". And this report says it's unavoidable for ten years, seven of which to drag the rest of us down that have managed (up to now) to pay bills.

Who's the fool here, those of us who have held out and paid our mortgages with declining incomes or those who walked away from a family home?

NOTE; my small business loss is not reflected in any measure of employment... yet is quite real.

Many moving parts to the economy. You can't expect to push one button at this end of the machine and get a definite result at the other end.

Excess debt is "bad," but we certainly don't want our entire population to become savers rather than spenders unless we want a long grinding cycle of Japan-style "recovery."

Some debt can be quite good if the rate you pay on it is less than inflation or whatever else you get with that money has value - for instance education or income producing asset. When I graduated from professional school making $35,000/year and owing $70,000 in student loans, it seemed like an insurmountable debt. 18 years later my earnings have grown while the monthly payment has remained the same. Now, I'm giggling about that monthly payment that used to give me heartburn. Best purchase I ever made!

Bad debts are things with no intrinsic value, single use and done, or assets that rapidly depreciate in value. Clearly worse if you are borrowing at interest rates 7-8 inflation in order to have them. But boy doesn't that make the economy spin to all of our benefit!!!

I'm not an expert on Japan's last 15 years and I know better than to challenge Morgan in his arena, but in the spirit of starting debate I'll give it a shot.

I'm going to counter your 4.7% unemployment with public debt to GDP ratio of 225%, 20 years of below global average growth in GDP (a paltry 1-2%). Given the title of the lead article I had to return serve with debt.

Given the complexity of Japans economy it is very difficult to tease out cause and effect of various factors. My my point was an expression of hope that SP500 in the next 20 years don't emulate Nikkei of the last 20 years.

I appreciate any ray of optimism (even if not entirely well founded). Here are a couple of other items to provide a bit of hope for the financial future: 1.) The government actually does have one form of "real" savings going on that's pretty substantial - the tax deferral on IRA & 401K accounts. By "real" savings I mean income/spending that has been forgone and invested in something with the expectation of a later return. (This is in contrast to bogus saving, like the SS trust fund, which doesn't fit a sane definition of saving). This is a lot of deferred tax revenue that will be flowing back into the treasury over the next 40 years. 2.) The baby boomer's parents are fairly wealthy, and as they start leaving the planet in very large numbers over the next 20 or so years, there will be a vast transfer of these assets to people who are pretty likely to start spending them. I think both of these will have a pretty positive impact.

Like ChemBaby, I connect pretty well with this article. I'm finally paying off my student loans at a decent clip rather than just making minimums, I've got personal savings and investment accounts (thanks to this site!) and keep my credit cards under a thousand dollars owed at any given time. I'm very much a part of this debt reduction procedure, and I'll be emerging from debt completely within the next 5 years. And I get the sense that others around me are doing the same.

It's definitely an optimistic sign.

Now if we could just increase taxes to a sane, 21st century level, the country could do the asme thing.

Thanks for this article. I was concerned that bankrupties were an overwhelming part of the debt reducition you spoke of too. If thats not the case then we are on the right track. We've been shedding debt as fast as we can too. Recently dropped our 25 yr mortgage down to 15yrs at 2% less in interest. Dropped the 2nd mortgage paid off all the Ccards, changed to lower interest there too and are trying to keep savings to cover those unexpected things that Ccards used to be used for. Like AC units that decide to die in the middle of summer. GRRRRRR.

Statistics don't lie, statiticians do. You are playing the same game as the government when you draw a graph starting at 15% and running to 20% "Household Debt as a % of Disposible Income". It is designed to show significant progress. Draw the same graph from 0% to 20% and the progress still shows but it lacks the same impact. Don't play games. The second chart is much better, it tells the same story more honestly.